Question

What is base money? Why is it important when considering the effects of monetary policy?

Answer 1

Base money is that which makes up a currency’s monetary base. It consists of both the total banknotes and coins in circulation and sight deposits held at central banks on behalf of commercial banks. It is created and circulated by central banks or monetary authorities.

When considering the effects of monetary policy, it is important to check the monetary base as it may encourage inflation or deflation by increasing or reducing the amount of base currency in circulation. The ratio of base money making up a currency in relation to the amount of book money based on the same currency is an important economic indicator for an economy.

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